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Those Loophole Houdinis May Escape Yet Again

April 11, 1999

Washington Outlook

Those Loophole Houdinis May Escape Yet Again

It's a ritual as old as the revenue code itself: Financial engineers take advantage of loopholes to devise exotic tax shelters, enriching corporate clients under the nose of the Internal Revenue Service. Eventually, the revenooers get wise. If the IRS can't halt the abuses under existing law, it asks Capitol Hill for a legislative ban. But by the time Congress acts, the loophole Houdinis are devising ever more inventive ways to shelter income.

In hopes of ending this game, the White House has begun an assault on abusive corporate shelters. In his fiscal 2000 budget, President Clinton pledged to outlaw more than a dozen questionable tax practices, such as transferring assets among corporate subsidiaries to write off the same equipment multiple times. And in April, Deputy Treasury Secretary Lawrence H. Summers will issue a report attacking egregious tax dodges. It will propose giving the IRS more authority to close loopholes on its own and to punish both shelter promoters and the companies that rely on them. It'll be a tough sell. But under the status quo, says Summers, "one is reminded of painting the Brooklyn Bridge. No sooner is one section painted over than another appears, needing work."BROAD CRACKDOWN. In the 1986 tax-code overhaul, Congress stamped out most individual shelters. But new ones keep sprouting in the corporate world. Tax-law complexity makes finagling hard to resist. Besides, investment bankers and tax pros are pushing deals on their clients, and CFOs fear being left behind in the rush to trim taxes. "You don't want to be the one paying the highest effective tax in your business," says one accountant. Stanford University law professor Joseph M. Bankman figures such loopholes save companies $10 billion a year.

Case in point: wildly popular lease-in, lease-out transactions. Under these deals, a U.S. multinational leases the town hall of, say, a Swiss municipality, prepays the rent, and takes a quick tax deduction. It then immediately leases the building back to the town but doesn't take payment until the next year. The result: a deduction now, and no income until later.

Treasury is trying to halt such arrangements. But the Administration thinks a broader crackdown is warranted. Its most explosive idea: giving the IRS power to bar transactions that are designed to avoid taxes--but serve no economic end. They also want the agency to expand its practice of issuing rules that retroactively zing completed deals.

The Administration's planned crackdown has already stirred strong opposition. "Treasury took a spaghetti approach," says Phil Wiesner, head of the national tax practice of KPMG Peat Marwick. "They threw a wide array of proposals against the wall to see what will stick." House Ways & Means Committee Chairman Bill Archer (R-Tex.) says next summer's tax bill probably will include some anti-shelter provisions. But he has stopped short of embracing the broad prohibitions Treasury wants. Even congressional Democrats are skeptical that unleashing the IRS is the right way to go. "Treasury has clearly identified a real problem here," says one Hill Democratic aide. "But I'm not sure they have the solution."

In the end, the Administration is unlikely to get many of the reforms it wants. Heightened attention to the shelter issue could prod Congress into shutting down a deal or two. And lawmakers may grant the IRS additional power to require disclosure of iffy deals and increase penalties for the most abusive shelters. As for a blank check to halt loophole-users in their tracks--don't bank on it. A year after curtailing the IRS's ability to squeeze individual taxpayers, Congress isn't about to let its least favorite agency kill off all of Corporate America's tax-avoidance schemes.By Howard GleckmanReturn to top